Natural Gas…Be an Informed Consumer

The price of energy is an important component to any form of large-scale industrial production. Natural gas has long been a chief source of energy for many industrial users, but it has become even more attractive lately given the sustained low-price environment. Improvements in shale gas technology over the past decade have given the United States record levels of natural gas production. Production has risen to such heights that in 2017 the United States exported more natural gas than it imported for the first time since 1957. That trend has continued this year and is expected to intensify in the years to come. At the same time, consumption of natural gas within the United States has continued to increase, primarily driven by the increased usage of gas in the production of electric power. Thus, we have seen both domestic and foreign demand rise to meet the increase in domestic supply.

The price of natural gas has been relatively stable over the past few years. The main price benchmark for the industry is the price at Henry Hub in Erath, Louisiana. Near-term futures contracts there have not surpassed $4.00 per million British thermal units (MMBtu) since late in 2014. This is a sharp contrast to the previous decade, when gas at Henry Hub was typically priced above $5.00 per MMBtu, and occasionally higher than $14.00. Furthermore, the futures market is currently in backwardation, with the price of gas in the coming years somewhat lower than the price of gas now. An informed consumer must have knowledge of the risks that gas market volatility might return. The factors underlying these risks are production, consumption, exports, weather, and storage.

As mentioned previously, the production of natural gas in the United States has soared since the development of newer hydraulic fracturing and horizontal drilling technology. The following statistics, and most statistics throughout this article, are taken from the Energy Information Agency (and can be found at eia.gov). In 2000, only 7% of natural gas produced in the country came from hydraulically fractured wells. By 2015 this figure had grown to more than 67%. The fracturing technology relies on water and sand shot at high pressure to penetrate the hard shale rock formations where gas is found. Shale formations from four areas now account for 50% of all the gas produced in the U.S.: Marcellus, Utica, Haynesville, and the Permian Basin.

The greatest impact to the gas market over the past decade has come from increased production in Marcellus and Utica, which are overlapping shale formations in Pennsylvania, West Virginia, Ohio, and New York. These two formations in northern Appalachia together account for 29% of all the natural gas produced in the United States, and are characterized by low break-even prices for the producing companies. Production in this region was previously hampered by a lack of pipelines to bring the gas to highly populated markets, but the completion of the Rover and Nexus pipelines should greatly increase take-away capacity, allowing producers to ramp up the supply. Crucially, there are minimal oil reserves in Marcellus and Utica, so the oil price has little effect on encouraging or dissuading gas production.

Another important area for natural gas production is the Permian basin in West Texas, which is currently producing 11% of total natural gas production. That area is also facing pipeline constraints, but new lines should resolve those problems in a few years. The Haynesville shale on the border of Texas and Louisiana has also seen an uptick in gas rigs recently, and it has far fewer problems with constrained pipelines. Both the Permian and Haynesville contain large amounts of crude oil, as well as natural gas. As the price of crude has increased over the past year, exploration in both regions has increased. In the future, if the price of oil dips, the amount of drilling in these regions will decline, thus raising the price of natural gas.

On the consumption side, natural gas has many uses in the American economy. Roughly 34% of natural gas is consumed by the industrial sector, while 11% is used by other commercial enterprises, and 16% goes to residential heating. The segment that has changed the most in the past decade is the gas consumed by electric generation. The low price of natural gas and more stringent environmental regulations have encouraged the trend of coal and nuclear plants shutting down and being replaced by natural gas plants. However, renewable energy sources such as wind and solar have also been expanding their share of power generation at the expense of coal. Future changes in regulation and market conditions will determine whether gas-fired power plants will continue to proliferate, or if the growth of renewables will intensify until they dominate new power production.

Although the United States has been a net importer of natural gas for over half a century, it is quickly transforming into a major net exporter. According to the EIA, during the first seven months of 2018 the U.S. exported almost 4.5 billion cubic feet (Bcf) per day of natural gas to Mexico via pipeline. These exports have been abetted by an expanded pipeline network in that country. In addition to our pipeline exports, we have also exported 2.8 Bcf per day of liquified natural gas (LNG) from two terminals: the Cheniere Sabine Pass terminal in Louisiana and the Cove Point terminal in Maryland. The top importing countries for this LNG include Mexico, South Korea, China, Japan, and India. Three additional large LNG terminals are expected to come online in 2019: Cheniere at Corpus Christi, Freeport LNG, and Cameron LNG. All three are along the Gulf Coast of Texas and Louisiana. The export capacity of the U.S. will be doubled by these new facilities, which will put some upward pressure on prices here at home.

In the short term, the amount of gas in storage has a major impact on prices. As a large proportion of natural gas is used for heating, the weather has a major effect on demand. However, it is extremely difficult to start and stop gas flowing from wells according to demand. To ensure that supply and demand are matched, companies pump natural gas into vast underground storage facilities in the warmer months, and withdraw the gas when the weather gets cold. The amount of natural gas currently in storage in the continental United States is lower than it has been at this point in November for any year since 2005. If winter is extremely cold this year, storage will run dangerously low, leading to price spikes.

This brings us to the last of the major factors impacting the gas market: the weather. Cold weather in winter can cause the price of natural gas to spike, as happened last winter. Additionally, very hot weather can also cause prices to become higher, as natural gas is an important contributor to the electric grid, and air conditioning is a major user of electricity. For this winter, the National Oceanic and Atmospheric Administration (NOAA) forecast predicts that warm weather will predominate west of the Mississippi and in the far northern states of the East. Meanwhile, the Southeast is predicted to have fairly typical weather. If this forecast is accurate, then weather will put no upward pressure on natural gas prices this winter.

Many of the elements affecting the price of natural gas involve long-term factors that will play out over succeeding decades. Others depend on short term factors such as the weather or a brief outage on a specific pipeline. It is important to keep in mind that volatility in the gas market can come very quickly. Planning to manage and control this volatility should be an important part of the business plan of any natural gas consumer.